I help parents reduce the cost of college and pay for it as wisely as possible. With the cost of the most expensive colleges today now in excess of $65,000 per year, even students from families with incomes over $200,000 can qualify for need-based aid. But it's often a combination of tax savings and financial aid that saves families the most money when paying for college. I am the CEO of Stratagee.com, a provider of college planning advice to families and college planning software and services for financial advisors. I have spent twenty two years pioneering this field, integrating expertise in college admissions, financial aid, tax aid and the family's personal resources into a best strategy.

College Savings: Are You Ready For A Major Market Decline?

“Goldman (Sachs) to Clients: Get Out of Stocks Before Fiscal Cliff Hits.” This was the headline on CNBC.com today that came out as I was starting to write this post. With stocks nearing technical peaks, and bonds showing early signs of a major reversal after a multi-decade bull run, I have been concerned for families with money invested for college. I know what the technical analysis is saying that I follow, but to get some insight from what was being said in the media late last week, I took a spin around five or so financial websites to see if any warnings were being voiced. I found the usual dire warnings for corrections in both stocks and bonds from Marc Faber and Nouriel Roubini (the Roubini highlight film is here), but was surprised that PIMCO, Vanguard and Bank of America had joined the public alert system with some trumpeting of their own. Individuals like Dent, Domm, Dobosz, Adami, Levi, Baker and Whitney have been sounding their alarms too, but this new headline about Goldman urging clients to get out of stocks is a chorus of trumpet blasts.

English: Nouriel Roubini, Turkish economist, professor of economics at the Stern School of Business, New York University. (Photo credit: Wikipedia)

Two of the reasons I am concerned about those investing for college are: Lack of downside protection in college savings accounts and the short time horizon before college funds will be needed to pay bills. Let’s say, for example, that a market decline does occur. Could a 20% decline in a family’s college savings accounts impact their ability to pay for college? It sure could, especially from a psychological perspective. Here again is another reason why I so often preach that a family’s best strategy to pay for college is an integration of college selection, financial aid, tax aid and the use of the family’s personal resources. Investing falls under the last category of making the best use of the family’s resources to pay college costs. This is yet another reason why college affordability involves a lot more than college aid, and why expertise in ALL FOUR AREAS is of the utmost importance.

Last Friday I was on a conference call with the panelists that I will be joining on a panel to discuss the future of higher education at Savingforcollege.com’s annual conference in late October. I commented that I was more concerned about what the future has in store in the next few months, before the conference, and how possible market events could shape the outlook on investing for college going into the conference.

Downside protection is the financial industry’s term for preventing losses in investment portfolios when markets decline. The common assumption that has prevailed among money managers over time is that asset allocation among stocks, bonds and cash helps to mitigate risk through diversification. Further, it is assumed that bonds are relatively safer than stocks in the short run, but stocks outperform relative to bonds in the long-run.

These assumptions are the reasoning behind what are referred to as age-based investment options, a combination of this asset allocation reasoning and a late-night infomercial for the Ronco Rotisserie, whereby age-based investors can “set it, and forget it,” just like the famous rotisserie’s tag line. Essentially, as an investor you can just put your money in the age-based account and the money manager will automatically change the allocation of stocks and bonds to a mix that is less heavy in stocks and more heavy in bonds and cash as college age draws near and the invested money will be needed for college. In other words, the portfolio managers do the basting and adjust the temperature so that your bird will be ready when the kid is about to fly the coup for Old State U.

However, if you find yourself in rare air, like stocks and bonds are at these present altitudes (price), the set-it-and-forget approach may not successfully adjust for such altitude, and you may be disappointed when the timer goes off.

If both stocks and bonds decline together, age-based allocations will decline too, and this is true for age-based allocations that are bond heavy for children that are closer to college. This is why portfolio managers use a variety of types of bonds like government and corporate, for example. And they pick bonds that mature (come due) over different time periods, long, intermediate and short-term. But with interest rates starting to rise, and rising interest rates mean bond prices decrease, managers have their work cut out for them. Bond prices have risen so high for so long that they are indeed in rare air, as are stocks.

The darling of all stocks, Apple (AAPL), reached an all-time high today as stock indices have pushed right up against the 1422 high reached back in April of this year, which is just below the 1,440 peak we reached clear back in May of 2008, and is still about 160 points shy of the all-time high we reached back in October of 2007. Yes, it has been almost five years now since the financial crisis began to unfold, and we still aren’t back to where we were in 2007 in terms of the S&P index.

The bigger question is if the financial crisis is about to unfold even more, with a déjà vu decline of 20-45% like some technicians are calling for. Technical analysts are indicating that many long-term cycles are converging that portend a sharp decline of 20% or more, followed by as much as a 45% overall decline in the subsequent 1-3 years. Forbes’ John Dobosz pointed out that the VIX (CBOE Volatility “Fear” Index) has just reached a new low, often a sign that investors are overconfident, and that stock declines soon follow.

So what are investors to do when such warnings and headlines are brought to their attention? Jeff Saut, the Chief Investment Strategist at Raymond James is oft noted to opine, “Focus on risk, not returns,” the main tenet of the legendary Benjamin Graham.

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“Based on this piece we should all stop investing in the stock market – for college, retirement or to generate income.

The College Savings Plans Network – a national non-profit association and the leading objective source of information about 529 Savings Plans – feels that the cost of NOT saving for college far outweighs these risks and that people should always be working to save for and invest in their child’s future. Students who have any amount saved for higher education in their name are six times more likely to attend a four-year college than children with no dedicated college savings account. By investing in 529 plans, parents can ensure that the next generation is not only better educated and employed, but understands the value of saving for the future.

529 plans offer a wide range of investment options. Nearly all plans offer age-based investment options where the underlying investments become more conservative as the beneficiary gets closer to college-age in an effort to reduce investment risk as the student gets closer to college age. In addition, most 529 also offer very low risk investment options for families who are concerned about investment risk, including guaranteed return options and FDIC and/or NCUA insured options. Just like any investment, account owners should periodically assess and adjust their portfolios to suit their needs.”

No, you should continue to invest but you need to periodically assess risk levels. This is one of those periods of time. You are absolutely correct that 529 plans offer stable value funds, money market options, CDs, etc. Those options mainly came about in 529 plans after investors lost money in previous market downturns. This isn’t a slam on 529 plans, it is a cautionary word about the risk in the markets. If I were writing about 401k plans I would urge the same caution, especially with target date funds. Utah’s 529 plan puts 100% of the age-based account money in FDIC insured accounts while the student is in college. That’s a good thing in this risk environment. I am not against 529 plans. I never said to stop saving for college. I am saying to be watchful of the money you have already saved for college, talk to your advisor and assess the risk level, then decide what to do. Are you really that forgetful that you do not remember that just a few years ago we saw stock market declines of 50%? So the 529 College Savings Plan Network responds to a warning about risk in the markets by saying, “that the cost of NOT saving for college far outweighs these risks and that people should always be working to save for and invest in their child’s future.” If I was an investor in one of your 529 plans that saw my account drop precipitously during the last market decline, I don’t think I would appreciate your comment here or your stance. It could be misconstrued that you are defending the 529 industry and not the investors. I know that investors and advisors would have appreciated a little warning before the markets declined starting in late 2007. I hear from them all the time. Maybe you will hear from them too. Maybe I am missing the point here; these plans are called 529 college savings plans, not 529 college investing plans. Perhaps then, all 529 plans should just use savings accounts instead of market-based investment options.